China’s bad data can be a good thing

Studied ambiguity: People playing checkers outside a Baoshang Bank Co branch in Beijing. One of the reasons non-performing loan ratios are so low is because the really risky stuff is hidden in shadow banking assets, as appears to be the case with Baoshang. — Bloomberg

There’s a good reason why China’s banking regulator just issued a statement insisting its small and mid-size banks were stable: Investors don’t believe the numbers that are telling them the same thing. In this particular case, though, bad data may actually be good policy.

Authorities themselves prompted recent jitters by seizing Inner Mongolia-based Baoshang Bank Co at the end of May, despite the fact that it supposedly carried a lower level of bad loans than China’s banking system as a whole.

Investors rightly worried about how bad the situation at Baoshang and its peers really was. While China claimed a non-performing loan ratio of barely 1.8% at the end of March, the real figure is thought to range from around 4% to as high as 20%.

In theory, getting this data right should matter. Market economies demand that banks offer an accurate accounting of their asset quality in order to ensure that they’re adequately capitalised. But, when I asked a senior Chinese financial regulator in 2013 if the official nonperforming loan data fairly represented bank asset quality, he gave an interesting answer: “Were China to disclose that it had significantly higher NPL levels,” he asked me, “would anyone benefit?”

He had a point. In China, the state stands behind the country’s banks. As long as authorities ensure those banks have sufficient liquidity to meet their obligations, they can trundle along with higher delinquency levels than would be regarded safe in a market economy. The government can stagger capital-raising by banks rather than do it all at once.

Indeed, the official explained, not recognising the true scale of bad loans gives Beijing the freedom to deal with them in its own way and at its own pace. It allows banks make write-offs from profit spread over multiple years. They can thus gradually drip nonperforming loans into the secondary market rather than dumping them en masse on disinterested investors. It also gives the authorities time to find ways to relieve pressure on overstretched borrowers before banks start demanding repayment.

Ultimately, such studied ambiguity allows Beijing to minimise both the disruption to the economy and the cost to the central government of cleaning up the banking system. China hasn’t wasted the opportunity.

Between 2016 and 2018, Chinese banks disposed of 4.4 trillion yuan (US$637bil) worth of nonperforming loans, equivalent to about 4% of total outstanding loans at the end of 2018.

Last year, China’s banks got rid of more bad loans than they acknowledged having in the first place.

Whether this strategy turns out to be smart or foolish will depend on whether China can overcome two hurdles.

First, whatever they tell the outside world, authorities must themselves grasp both the true scale of the problem and, importantly, where the main risks lie.

One of the reasons nonperforming loan ratios are so low is because the really risky stuff is hidden in shadow banking assets, as appears to be the case with Baoshang.

That the regulators were able to move so quickly and decisively to deal with Baoshang suggests they have a good understanding of what’s going on.

Second, the government must keep up the pace of bad-loan disposals. Write-offs surged last year, with the Big Five banks increasing their disposals by 74% and joint-stock banks by 38%.

As the Chinese economy slows, however, it’s going to become harder and harder to get rid of bad loans more quickly than they’re created.

Already there are signs that smaller banks aren’t keeping up with the cracking pace of disposals set by their larger peers.

If progress slows, the government may need to intervene more forcefully, as it did with Baoshang.

China has so far managed to make significant strides in dealing with their bad loans at a minimum cost to the government and the economy.

That’s no guarantee it’ll be able to keep up the juggling act forever. — Bloomberg

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.